Reform Ahead for Mark-to-Market?

The national mark-to-market accounting standard requiring assets to be priced at current market value, a flash point for many commercial real estate investors, is moving up the list on Washington's agenda for reform.

A congressional subcommittee heard testimony on March 12 on the accounting standard. Lee Cotton, former president of the Commercial Mortgage Securities Association (CMSA) testified that the government's mark-to-market rules are imposing hardship on the $3.4 trillion commercial mortgage market at a time when participants already are burdened by the distressed economy.

“While CMBS (commercial mortgage-backed securities) market participants are struggling with the paralyzing effect of the credit freeze, they are simultaneously faced with the highly problematic and related effect that the FVA (fair value accounting) standard is having on their balance sheets,” Cotton told the Subcommittee on Capital Markets, Insurance, and Government-Sponsored Enterprises.

The association supports the fair value standard, but wants changes in the way it is applied, Cotton said. “We believe it works when the markets are functioning and there is not extreme volatility.” In the current unstable market, distorted data is being used to value assets, and it does not take asset performance into account, he said.

Since the hearing, the accounting rules have become part of the regulatory reform agenda of the House Committee on Financial Services and further discussions will be scheduled, says spokesman Brian Kelly.

Mark-to-market accounting requires valuing assets at current market values, under rules set by the Financial Accounting Standards Board (FASB). The Securities and Exchange Commission (SEC) tasked the board with setting standards for financial reporting.

The mark-to-market rules have prompted a groundswell of complaints from investors and lenders who say they force companies to value performing assets at fire-sale prices.

Congressman Paul Kanjorski (D-Pa.), chairman of the subcommittee that held the hearing, says some companies have written down billions of dollars worth of assets. He hopes to provide investors with essential information without unduly burdening financial institutions, he says.

Turmoil in the financial markets has brought CMBS lending to a virtual standstill. It's a sea change from 2007, when CMBS powered the market with $240 billion in U.S. issuance, nearly 50% of all commercial lending. In 2008, CMBS financing plunged to less than $13 billion in U.S. issuance, the association reports.

Federal Reserve Chairman Ben Bernanke and SEC officials have indicated that while they support fair value standards, they are open to fine-tuning the requirements.

However, Cynthia Fornelli, executive director of the Center for Audit Quality, whose governing board includes leading auditors and investors, warns that weakening the fair value standard, or FAS 157, could harm the nation's economic health.

Fornelli cites the 1980s savings and loan crisis, when financial statements obscured some declining financial institutions' assets and liabilities, worsening the damage from their failures. “Changing accounting standards to remove much-needed transparency would likely undermine investor confidence,” she concludes, “and could prolong the current crisis.”